We have discussed some of the problems with Cost Accounting, yet only touched on the alternative, “Throughput Accounting”. We promised to explore Throughput Accounting in more depth, and explain how implementing its concepts will help you understand the rate at which your company makes money. We also promised to discuss how Throughput Accounting can influence pricing decisions.
We are discussing Throughput Accounting from the perspective of the Theory of Constraints (TOC), a body of knowledge developed by Dr. Eliyahu M Goldratt and others over the last thirty years to support a process of ongoing improvement.
The fundamental concept in TOC is that every real system, such as your for-profit business, must have at least one constraint. If it were not true, your business would produce an infinite amount of net profit. Because a constraint limits your business system from getting more net profit, then if you want more net profit you must manage constraints. These constraints will determine the net profit of your business whether they are acknowledged and managed or not.
TOC and Throughput Accounting introduce three measurements for increasing net profit:
1. increase Throughput (Sales minus truly variable costs such as raw materials),
2. decrease Investment, particularly in inventories,
3. decrease Operating Expenses (that is, fixed costs).
…to be continued.
Here’s to maximizing YOUR profits!
Dr Lisa Lang